WASHINGTON, May 14 (UPI) -- As discussed in my "Bear's Lair" column Monday, the Washington Consensus collection of economic development policies have been most intensively applied in Latin America, with mixed and latterly disappointing results. The question naturally arises: what should Latin America do next?
A study sponsored by the Institute for International Economics, "After the Washington Consensus," co-authored by Pedro-Pablo Kuczynski (Finance Minister of Peru, 2001-02) and John Williamson, of IIE, attempts to answer this question by means of 11 essays on different topics by 15 scholars, 12 of whom are Latin American.
Unlike the original 1989 IIE book "Toward Renewed Economic Growth in Latin America," which developed what became the "Consensus," the new book demonstrates a number of different ideological viewpoints, and thus lacks a coherent core to its recommendations. For example, the article on public finances, co-authored by former Argentine Finance Minister and presidential candidate Ricardo Lopez Murphy, recommends much tighter control of public finances in the region, which it sees as a leading problem. On the other hand, the article on poverty reduction, written by Nancy Birdsall of Washington's Center for Global Development and Miguel Szekely of Mexico's Ministry for Social Development, recommends extensive state-financed transfer payments to the poorest in society. The two recommendations are of course almost wholly mutually incompatible.
The economic problems of Latin America stem from one core source: excessive centralized government control of the economy, together with a cultural environment that resorts to rent-seeking at every possible opportunity and does not sufficiently penalize corruption of every kind.
This manifests itself in several ways. One is the pro-cyclical nature of public spending, as well brought out in the Lopez Murphy chapter. When resources are easily available, because foreign lenders are eager to lend and tax revenues are buoyant, Latin American governments spend money eagerly, with the correlation between government spending and gross domestic product at 0.53, as high as that between tax revenues and gross domestic product (so there are no automatic fiscal stabilizers) and much higher than the spending/GDP correlation of around zero for Group of Seven most industrialized countries, or G7 countries, and 0.2 for industrial countries as a whole.
Latin American governments of a free market orientation try to assuage the flow of spending by reducing taxation, but of course that, too is pro-cyclical. In addition, because governments spend so freely in good times (with the Brazilian budget deficit, for central government alone, averaging 5.8 percent of GDP in the 1990s) there is a rapid fiscal crunch when times get hard, and so the usual remedies of increasing spending or (better) reducing taxes counter-cyclically in a recession are not available.
The tendency of public spending to run away with itself is exacerbated by the region's public sectors, national and local, which generally have above average incomes and very strong trades unions, and the eagerness of local politicians to promise ever-rising pension benefits, again concentrated on the wealthier population, without any regard as to how they are to be paid for. As Lopez Murphy points out, the implicit pension debt in Brazil, for example, is around 200 percent of GDP, an amount that is hopeless to attempt to finance by conventional means.
The second, and even more serious manifestation of Latin America's core problem is the persistent mistreatment of middle class savers, and those without political power in general. While the high inflation of the 1980s, which wiped out so many stores of savings, appears to have been eliminated (to the great benefit of the GINI inequality coefficient in Brazil, for example -- unless you LIKE extreme inequality) the Argentine semi-expropriation of domestic savings of December 2001 demonstrates that the region's leaders are Bourbon in their determination to learn nothing and forget no looting technique.
Inequality in the region would be greatly improved by allowing the poor people access to a reliable store of value for such savings as they manage to amass; the "liberalization" of the region's banking system, which provided no additional access to the 90 percent of the population without bank accounts, was counterproductive in this respect.
The principal cause of the region's poverty is of course its inequality, the highest in the world. As the book elegantly points out, without Latin America's very high levels of inequality its levels of poverty would be orders of magnitude lower, and its social problems infinitely more soluble. It is here that the book falls down. Transfer programs to the poor suffer from two problems: the resources to fund them have to pass through government, which is a source of corruption, and the taxes you increase to attempt to pay for them are evaded by all but the most docile in society. The tax evasion rate in Latin America ranges from 23.3 percent in Chile up to 68.2 percent in Peru. Hence increasing tax rates to pay for more social programs, which has in any case been tried far too many times in the region, will inevitably fail again and worsen the region's overall economic problem.
The region's inequality stems from a single primary cause: the existence of labor laws, social programs, pension schemes and social protections that are unaffordable to the society as a whole, and hence entrench the politically powerful -- unionized labor and the public sector -- at the expense of the economically marginalized poor and struggling small business.
The book demonstrates clearly that in only one society in Latin America -- Chile -- did poverty drop substantially during the 1990s, falling from 45.1 percent to 23.2 percent between 1987 and 1996. But of course, Chile is the one country in the region that for the 16 years 1973-1989 was ruled by a dictator, Agosto Pinochet, who did not have to seek frequent re-election, nor popular approval of his policies, and who could thus afford to take on and defeat the vested interests of unionized labor and the public sector.
After the fall of Pinochet, from 1989 to 2000, the Chilean democratic governments kept sight of Pinochet's successes, and ensured that there was little or no backsliding on his policies. Only after the election of socialist president Ricardo Lagos in 2000 have the labor unions and the public sector once more gained a powerful voice in Chile, and there is every sign that, whether or not Chile signs a free trade agreement with the United States, they are again having their usual pernicious effect, sharply narrowing the gap between Chilean success and Latin American failure.
From Chile's example, the keys to economic success for Latin America are very clear. Slash the featherbedding of the public sector and the labor unions, allowing the economically marginal to inherit the economic space they leave behind. Cut back government as a whole, sharply lowering tax rates but making sure that taxes are properly paid -- this has worked for Vladimir Putin's Russia, it will work in Latin America. Above all, have as your top priority the protection and nurturing of domestic middle class savers, so that the habits of thrift and accumulation that lead to economic success are fostered, and small business finance is readily available from domestic sources.
Lagos, in a period of economic collapse, got no more than 16 percent of the vote with approximately this program in the first round of Argentina's recent elections. This suggests that such a program is "politically impossible" in Latin America today. If that is truly the case, then a Pinochet-style dictatorship is the only way in which such a program could be enacted in the region.
The book attempts to "square the circle," integrating the policies necessary for economic success with the demands of Latin American democracy. But in the end, that may prove to be impossible. It is to be hoped, for the sake of the economically marginal in Latin America, that we do not spend too many more decades proving that impossibility.